Thus far, April hasn’t been a particularly positive month for the MLP space either, as the ETF has tracked the downward trend of the broader S&P 500 for a loss of just over 2%. Still, I see this as an opportunity to lock in a better yield on shares.
The fund holds a capitalization-weighted portfolio of 25 primarily midstream MLPs, including names such as Enterprise Products Partners (EPD), Kinder Morgan Energy Partners (KMP) and Magellan Midstream Partners (MMP).
Enterprise Products Partners operates both onshore and offshore natural gas and crude oil pipelines and storage facilities, 25 natural gas processing facilities and two natural gas import and export facilities. Kinder Morgan Energy Partners owns more than 35,000 miles of pipeline and 180 crude, natural gas and bulk materials terminals. Both companies operate in the largest and fastest-growing, energy-producing regions in the U.S.
While obviously energy-focused, the operations of most midstream MLPs are fairly diversified and largely insulated from commodity prices. Rather than being paid according to the value of the commodities they move, pipeline operators are paid by volume.
Given that midstream operators’ profitability is driven more by aggregate demand than commodity prices, I remain extremely positive on the sector.
A surge in drilling and production activity in U.S. shale oil and gas plays is spurring huge demand for additional pipeline capacity. In fact, the abundance of natural gas trapped in regions that lack the infrastructure to transport them elsewhere is one of the reasons the commodity has become so inexpensive in the U.S.
As a result, MLPs such as Energy Transfer Equity (ETE) have proposed the construction of a number of new export terminals to allow the sale of US liquefied natural gas on the international market. A critical component of those plans is the construction of additional pipeline capacity — which won’t cross international borders and require presidential approval — in order for the gas to reach the coasts. That will spark a profitable building boom for pipeline MLPs.
Another potential boon for natural gas stocks is the fact that a number of electric utilities such as Southern Company (SO) have announced plans to switch from coal to gas. With natural gas prices near historic lows, utilities are moving to capture the cost advantage as well as the opportunity to reduce carbon emissions. That, in turn, is lowering costs for consumers, which should boost electricity demand and create a virtuous cycle for gas prices.
ALPS Alerian MLP ETF currently yields 6%, one of the highest yields in the exchange-traded fund (ETF) space. The reason for such an impressive payout is the structure of MLPs; they’re not subject to corporate-level income tax, so most of their income is passed along to investors. But this isn’t a case of questionable companies making higher distributions just to attract investors; these are strong companies that take advantage of a unique structure to maximize unit-holder returns. And as my colleague, Roger Conrad stated in Sticking To Master Limited Partnerships Continues to Pay Off, many have been able to tap into relatively inexpensive financing to fund acquisitions and organically grow their businesses. As a result, payout growth in the sector has averaged between 5% and 6% over the past several quarters.
So while there are some short-term headwinds still in place for MLPs, the long-term growth story for the sector remains intact. For more on MLPs, check out the free report: Top MLP Investments.